a the subsequent is a discussion based upon ifr


(a) The subsequent is a discussion based upon IFR Special Report in issue 1239 during the Year 1998.

Danish mortgage bonds have extended been domestic investors' referred debt instrument. The combination of a high degree of security as well as a spread over government bonds signifies that Danish mortgage bonds form the foundation of the majority of domestic portfolios, professional as well as private investors.

In current years international investors have taken rising interest in the Danish mortgage market and foreign holdings have expanded from DKr40bn (4%) in 1994 to approximately DKr75bn (7%) in the first quarter of 1998.

Therefore of more widespread investor interest most banks have had their mortgage bonds rated by one of the major US credit rating agencies. Moody's Investors Service has allocated ratings of between Aa2 and Aa3 to mortgage bonds issued by Danish mortgage lenders. The reality that no Danish mortgage bank has ever defaulted on its obligations during their 200-year history substantiates the bonds' high degree of safety.

(b) There are two main explanations for the increased international interest in Danish mortgage bonds. First international investors have become supplementary technically oriented most are no longer deterred from including complex structured securities in their portfolios. The prospect of European Monetary Union has made stronger this development in Europe. Several American investors in particular find that the Danish sector for mortgage bonds is extremely similar to their domestic mortgage-backed market. Subsequent the Danish mortgage bond market offers a number of attractive investment openings that may raise the return on a diversified portfolio of debt securities.

With approximately DKr1, 013bn in movement the market is relatively large even by international standard. It is extremely much the market for government bonds which has attracted foreign investors for many years and has an outstanding volume of DKr670bn. A numerous classes of mortgage bonds are able to compare with the biggest series in the world.

The table below outlines the main features regarding the most liquid Danish mortgage bonds although there are transactions with other features

Coupon 4%-8%

Life 1, 10, 20 or 30 years

Annual repayments 4 and 1

Repayment profile: Annuity payments but as well bullet bonds and serial bonds. Most bonds perhaps prepaid at par. Termination of a loan generally requires a two-month notice prior to the date of payment.

Market making For the most liquid bonds- several 15 brokers is under an obligation to quote amounts of typically DKr25m to DKr50m Futures exist in a basket of the 6% bond of 2029 and the 7% of 2029. The Danish market for futures as well as options is relatively illiquid.

(c) Pricing of Danish mortgage bonds is conquered by the prepayment element. Assessment of future redemption rates is the predominant factor in connection with analysis and pricing. As a result Danish stockbrokers have a long tradition of analysing as well as assessing callable bonds and have developed standard pricing methodology. In this circumstance the mortgage banks via the Copenhagen Stock Exchange provide a number of data such as an outline of debtor distribution and weekly prepayments to support the assessment of the prepayment volume. International investors are likely to invest in bonds with the lowest prepayment risk. Most prefer low-coupon bonds which as well reduce the probability of a negative convexity.

The expected added yield compared with government bonds depends among other things on lifetime, coupons and liquidity. The spread to government bonds is comparatively high which signifies the option adjusted spread (OAS) on a number of benchmark bonds is approximately 70bp compared with an additional yield of only some 20bp to 25bp on the longest German jumbo Pfandbriefe.

 (d) Pricing of Danish callable bonds is usually speaking based on assumptions about the likelihood that the debtor will call the bonds under different interest rate scenarios. A binomial model explaining the future direction of interest rates combined with distribution assumptions describing debtors' behaviour patterns in the given interest situation is generally applied.

The behaviour relating to calls is usually based on the debtors' profit claims this is typically assumed to be log-normally distributed. A number of key ratios such like theoretical price, option- adjusted spread, option-adjusted duration and more can be calculated on the basis of the defined binomial tree and the calculated prepayment gains.

Additionally to advanced option models CPR models and various equilibrium models are also applied to some extent.

(e) The Danish bond market is characterised by exactly the same trade conventions and settlement procedures for government and mortgage bonds. Therefore most domestic brokers are able to trade government and mortgage bonds at the same desk.

Mortgage bonds in Ecu/euro like of June 2 1998 Nykredit has issued bonds denominated in Ecu that will mechanically be redenominated in euros as of January 1 1999.

The range of loans comprise non-callable bullet loans with maturities of 1 to 11 years with coupons of 4% and callable annuity loans with maturities of 10, 20 and 30 years carrying coupons of 4% for bonds unpaid between 2008 and 2018 5% until 2028 and 6% for even longer securities.

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Financial Management: a the subsequent is a discussion based upon ifr
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